How to be a property investor: Property vs pensions
New pension rules which came into effect last year give retirees much more choice about what they can do with their pension pot.
Before April 2015 pension savers had little choice but to buy an annuity on retirement. Now they have the option to withdraw their pension as cash or leave it invested in the stock market. Read our guide to the new pension freedoms.
The pension rule changes came at a time when property investors were boasting impressive returns. Property has outstripped every asset class over the past 20 years and is showing no sign of slowing down.
However, there is one big issue to consider before you cash in your pension to join the buy-to-let brigade: tax.
Those aged 55 and upwards can take 25% of their pension as a tax-free lump sum. However, further withdrawals will be taxed at an individual’s marginal rate of income tax and this can mean a hefty tax bill for many.
For example, if you had a £200,000 pension pot you could take £50,000 tax-free. If you were taxed at 40% on the remaining £150,000, you’d pay the tax man £60,000.
Income tax aside, money in a pension has no capital gains tax liability and the money is outside of your estate for inheritance tax (IHT) purposes. None of these benefits apply if you take the money out and purchase a property.
Buy to let tax changes
Investors buying the average property costing £292,000 now pay £13,360 in stamp duty compared to just £4,600 if they’d bought the property before 1 April.
There are also changes to the way rental income is taxed on the way. From April 2017 the Government is slashing the amount of tax relief on mortgage payments landlords can claim to the basic rate of 20%. The changes will be phased in from April 2017. Landlords who pay basic rate tax won’t see a change, but those on higher incomes will lose out.
- Read our article Is it goodbye to buy to let?
Tax is the main reason financial advisers generally advise against cashing in a pension pot to buy a rental property. Some go as far to suggest landlords make the move the opposite way by selling buy-to-let properties to put money into their pensions.
Beware of the buy to let “hassle factor”
However, it’s not just tax retirees need to think about when weighing up the pros and cons of buy-to-let. Despite suggestions from some quarters that landlords earn money for nothing, the opposite is often true. Unlike investing in the stock market, buy-to-let is far from a passive investment.
Obviously the first step for landlords is to find the right tenants. After that there is collecting the rent, maintaining and repairing the property, and dealing with any issues that arise. And that’s just when things are going well. Unfortunately buy-to-let can turn into a nightmare if tenants fail to pay the rent or damage the property. Non-paying tenants can take months to evict and all the while the mortgage will still need to be paid.
So, far from providing retirees with a hassle-free income in retirement, in some cases buy-to-let can become a tiresome burden.
- Don’t miss the first articles in this series, Our national love affair with property and A history of property prices.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
Tax-free lump sum
An inelegant phrase that is nonetheless accurate in what it describes: a one-off payment to a beneficiary that is free of any form of taxation. Usually received when using a pension fund to purchase an annuity, as 25% of the overall fund can be taken as a tax-free lump sum.
A hugely unpopular tax paid on property and share purchases. Stamp duty on property is levied at 1% for purchases over £125,000 (£250,000 for first-time buyers) which then moves up at a tiered rate. For property between £125k and £250k you pay 1%, then 3% from £250k up to £500k and then 4% from £500k to £1m and then 5% for properties over £1m. But unlike income tax, which is “tiered” and different rates kick in at different levels, stamp duty is a “slab” tax where you pay the rate on the whole purchase price of the property. On shares, stamp duty is charged at a flat rate of 0.5% on all share purchases. Figures correct as of May 2011.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.